Tax investigations: what to do and what not to do

With a tax gap estimated at £40bn, HM Revenue and Customs (HMRC) is taking a tough, new approach to reducing the shortfall – and all businesses are potentially under threat of investigation.

It is difficult to overstate the disruptive impact investigations can have, not only on commercial operations, but also in some cases on the private lives of business owners

This risk has been significantly elevated because HMRC has been ordered to reduce the tax gap by £7bn over the next four years.

HMRC aims to tackle it with fresh initiatives against tax avoidance and harsher penalties against those breaking the rules. It is also improving its systems to capitalise more effectively on the vast amounts of information it holds.

All companies have been required to submit accounts and tax returns in electronic (iXBRL) format since April 2011. The information this yields will enable HMRC to compare results of individual companies with competitors, or with historical trends, to identify anomalies.

Businesses and sectors most at risk

HMRC uses the expression ‘breaking the records’. This means that once an inspector has shown weaknesses in any area of a company’s records, the credibility of the records as a whole can be undermined. This immediately gives the inspector a major advantage and HMRC has won a string of cases where it has successfully assessed businesses on its own estimated figures, simply because records were flawed.

Worse still, HMRC will argue it has justification for extending its investigation into the private affairs of the owner.

We expect HMRC to target businesses perceived as high risk. Companies that persistently file late returns, or pay tax late without contacting HMRC to explain why, will attract unwanted attention.

In the eyes of HMRC, a business that submits returns late does not take tax compliance seriously, and represents ‘easy prey’. HMRC will also look at the sector in which the business operates, and from time to time, will target particular areas. Hotels and restaurants in the North West are currently in the spotlight.

How to reduce exposure

Our TaxSafe scheme is a cost-effective insurance policy that covers the cost of our dealings with HMRC investigations from the moment they start an enquiry. This includes VAT or PAYE inspections, which we can attend at no cost to the business, and nip issues in the bud. The scheme also covers the cost of dealing with technical enquiries as well as full scale investigations.

Tax investigation work is a specialist and time-intensive area. It often surprises people that dealing with investigations can cost considerably more than the fee for preparing the accounts under review.

TaxSafe also represents a tactical advantage. Where HMRC inspectors know a company has TaxSafe in place, they will appreciate that the business owner has the resources to contest HMRC arguments.

What to do if an inspector calls

The first step is not to assume HMRC has contacted us about the investigation or inspection. Call us before you do anything.

The next step is to prepare, and our specialists will be able to advise you exactly how. The first meeting with HMRC is critical: inspectors are very good at catching taxpayers off guard in a friendly initial meeting, and then using ‘throwaway comments’ as evidence to support ambitious tax assessments at a later stage.

If you know something is wrong, don’t try to hide it. An early, voluntary disclosure will reduce any final settlement with HMRC. Keep in mind that at the end of an investigation, a certificate of full disclosure must be signed, and HMRC will take criminal proceedings against people found to have knowingly signed incorrect statements.

Keep cool, stay focused

When HMRC start an enquiry or investigation, it is for a reason. It should not be assumed the enquiry is a random event. In practice, virtually all investigations are started because HMRC inspectors think there is tax at risk. Thumping the table will not persuade them otherwise – just the opposite.

The key is to identify the concerns and deal with them. That way, the case can be closed at the earliest possible opportunity.